When ideas meet funds
Bridging the gap between ideas and funding has always been a challenge. Venture capital funding remains limited while crowdfunding has not yet proven to be a reliable source. A panel discussion at the 11th WIEF in Kuala Lumpur examined the different thought processes that entrepreneurs and investors bring to the table when they meet.
What venture capital funds look for
Jamaludin Bujang, former Chief Executive of MAVCAP Malaysia, acknowledged that venture capital (VC) funding in his country was still very small, with funds amounting only to around RM3 billion to RM4 billion. In comparison, loans from the Malaysian banking sector stand at around RM74.3 billion.
He explained that VC funding was more akin to refinancing, and with any project, the ratio of equity to loans will always be around one to four or five. He also noted that the demand side may be limited because VCs often manage their investments as active partners; not every entrepreneur liked the idea of a VC-partner coming into their firm. Thus, VC funding will naturally be very small in terms of providing capital to SMEs.
Jamaludin said VCs decide on their investments based on very specific mandates. Every fund will have a specific lifetime—generally 8 to 10 years—after which they exit all investments and return the capital to the investors.
“When you do that, you want to focus on certain companies that fit your mandate,”
he said. Thus, VCs with funds of USD50 million to USD100 million undertook only 10 to 20 investments.
VCs also have to be very selective, he said, because they bore a lot of risk as they take only a minimal stake to begin with (about 20 to 40 per cent), leaving them with less control compared to entrepreneurs. The VC, thus, needs to select companies that share their ideals, are willing to be partners in the decision-making process and in the Board, and to grow together.
As such, the global average is that only one to five in every 100 companies manages to raise funds this way. Most of the time, the remaining 95 per cent don’t succeed because their product has not reached a high level of development, the entrepreneurs may not be up to par, or the companies do not have good governance in place.
Funds and ideas sitting together
Eddy Lee, who founded Deft Intelligence in the US, said that the main problem in the startup world— especially in early financing—was that investors and startups were often referred to as being on opposite sides of the table. He believed that they should be on the same side because investors should be prepared to roll up their sleeves and participate in building the product and developing the business model. “That has to happen, and I don’t see that happening from my past few years of investing in Southeast Asia,” he said.
Lee noted that while technologies from the US will penetrate the Southeast Asian market in shorter and shorter periods, their success will lie in their business model which has to be made to suit the local environment. He gave the example of a telemedicine business in the US that would have a model based on the insurer as the payer—but in Southeast Asia, most markets were under-insured or uninsured. Thus, the business model had to be reinvented for lower pricing. “Business model innovation is very important,” he said.
He also said startups need to move beyond hype to focus on core issues like their customer value proposition.
Startups need to begin basing their achievements, not by the amount of funds that they have raised but rather, the customer value delivered and revenue generated.
“Those should be the key comparison in any business, not the amount of money raised,” he said.
“So when I look at the business, I always look for the business model. Are they creating value? Who is going to pay for it? Those are the key things I’m looking for and I encourage everyone to think about those things when pitching to any investor as well,” he said.
Martin Nygate, who founded Gentay Communications in Singapore, said entrepreneurs need to understand the profile of the different types of investors, how they invested, and at what stage. For instance, he said seed investors tend to invest small amounts of money in many companies that may have developed only a prototype; they may not necessarily understand an area very well but get excited by ideas. But as investments reach a higher level, the investors themselves would become much more professional. At each stage, there are different dynamics that determine the profile of the investor and what they are looking for.
“So when you talk about ‘speaking the same language’, you have to understand that investors have different strategies for investments,” he said.
Socially responsible investing
Ariff Sultan, who is Regional Director for Asia at IdealRatings Inc, Singapore, emphasised that more and more funds globally were moving towards socially responsible investing (SRI). Recently, he said, the Canadian Government announced that all funding into new ventures would have to meet SRI requirements— thus, a startup without clear guidelines on these issues would not get funding easily. There was also a consumer drive towards this end: for instance, products made by palm oil and pulp and paper companies deemed guilty of causing the Southeast Asian haze in 2015 were pulled o the shelves in Singapore and some other countries due to consumer anger.
Moderator Dato’ Dr Hafsah Hashim, Chief Executive Officer of SME Corporation Malaysia, led the discussion towards the new phenomenon of crowdfunding, asking the panellists for their thoughts on this.
Jamaludin said crowdfunding was still a new phenomenon although Malaysia was one of the first countries in Asia to introduce it locally. He believed that if it was to be successful, there has to be better education about crowdfunding— equity crowdfunding was generally targeted at the public but investors needed to know that it was actually very risky, and they should learn more about the company, its management and prospects. If people lost money without understanding the risks, there could be a ripple effect that might discourage others from participating.
In Nygate’s opinion, crowdfunding was still an immature way of funding startups while conventional methods had proven themselves more effective with much more predictable outcomes. However, he believed that crowdfunding had its place in specific products which consumers can understand very quickly (as opposed to more esoteric products).
Lee said equity crowdfunding might be able to fill certain gaps in the financing cycle but he did not believe it would have any real impact.
Are there any specific industries that funds are looking for in this century?
Lee: “The world’s population is heading towards 10 billion people, and there’s going to be scarcity in clean water and resources, and this can lead to higher spending on health by governments. We are already seeing that happen in the last 20 years or so. Another trend that we are seeing is that more and more people are going to be living in urban areas. Cities are going to turn into mega- cities, and there’s a move towards sustainable technologies within cities. Looking ahead and predicting these urban living problems, and finding solutions for them could be one of the areas that could be very interesting for investors and for any business.”
Does a lack of competition mean more of an opportunity for the entrepreneur, or is it actually a red flag because there is nobody for them to compete against?
Jamaludin: “Of course, you want to be the first out but you have to make sure that this company you invest in knows how to handle the competition. You don’t want to invest in companies that have no competition, of course, because you want to make sure that the company can also be resilient to market changes.”
Nygate: “This philosophy of not investing in a company or an industry where there is no competition is like the philosophy they teach in business school. I don’t want to subscribe to that. You want to get in very early, and someone’s got to lead the pack,
someone’s got to be the first. The guys who are out there in the front are the guys who are going to be the unique ones in the future.”
Numerically-wise, there are thousands of entrepreneurs that may be within more traditional industries, like lifestyle industries. Great innovation is also being done on that front. Do you think that venture capital institutions are probably overlooking these entrepreneurs?
“As a country, we should have many funds with different focuses. You cannot have one fund that can invest in everything because you are going to dilute your expertise. VCs have certain specific skills, and certain areas that we are good at.”
Keep on looking
In closing, moderator Dr Hafsah noted that while there were many extant funding sources, entrepreneurs had difficulties accessing them.
“It’s like water—water everywhere but not a drop to be seen,”
she said. VC funds looked for businesses that fit their specific mandates and entrepreneurs they could work with to grow the business; and increasingly, many also included social purpose as a criterion. Dr Hafsah observed that while crowdfunding was still new and not yet a significant source of funding, it could nonetheless fill important gaps in funding.
This report is based on a session from the 11th WIEF in Kuala Lumpur, Malaysia.